Soaring skywards

An aerial view of Bangalore. The city has overtaken larger metropolitan cities such as Mumbai or Delhi because of its more realistic land prices. - THE HINDU PHOTO LIBRARY

There has been an unprecedented boom in the real estate sector in the country, fuelled by the demand from various industries and the liberalisation policies of the government.

THE housing and real estate sector in India is undergoing an unprecedented change. Real estate development in India, estimated to be in the region of $12 billion, is growing at a pace of 30 per cent each year. Almost 80 per cent of real estate developed is residential space, and the rest is comprised of offices, shopping malls, hotels and hospitals. This double-digit growth is mainly attributed to the off-shoring business, including high-end technology consulting, call centres and programming houses, which in 2003 were estimated to have accounted for 10 million square feet of real estate development.

The sustained demand from the Information Technology (IT) sector has certainly changed the urban landscape in India. It has been estimated that the demand for IT space would be 66 million square feet over the next five years. The case of Bangalore, which has been on a new trajectory since 1998 is worth noting. It overtook larger metropolitan cities such as Mumbai or Delhi because of its more realistic land prices. Bangalore soon gave up its title as the Garden City to become India's Silicon Valley, positioning itself as the IT capital of India.

Several multinational companies continue to move their operations to India to take advantage of the relatively low costs. With human resources being the key element in this industry, hiring people and housing them assume great importance. The need to create space for people to work and live triggers the development of other related infrastructure.

The predominant trend in Bangalore has been to set up world-class business centres, often campus-style establishments, bearing a distinct corporate stamp. So distinct are some of these locations that they are being termed the "temples of modern India" x an indication of the extent of real estate development. However, the drawback was that while real estate development reached world standards, the urban infrastructure in the city could not keep pace. Power shortage and the lack of an effective public transport system were the key problems. This paved the way to explore other alternative locations. As a result, similar developments took place in cities such as Chennai and Hyderabad.

But this served as a wake-up call for the authorities: real estate and urban infrastructure are inextricably linked and the development of one is closely dependent on the other. This also led to the setting up of the Bangalore Action Task Force, a popular and successful public-private partnership project, to transform Bangalore into a world-class city.

Another case in point is the New Delhi suburb of Gurgaon, which has seen a radical change in not just its skyline but also in its basic urban demographics. Gurgaon was once described as just a little town built on a pasture. But in the past three years, six malls have sprouted in Gurgaon and five more are under construction. Gurgaon is a shopper's paradise and the malls are vertical versions of their U.S. counterparts: five-storey bazaars, housing almost every international brand along with multiplex cinemas, escalators and huge parking lots.

The obvious question one may ask is: on what are these malls thriving? The answer is Zippies x a term coined by a Delhi magazine to describe the huge cohort of Indian youth or "liberalisation's children". 'Zippies' are typically young city or suburban residents in the 18-25 age group, with a zip in their stride, oozing with ambition and aspiration, with no qualms about making or spending money.

The advent of call centres, programming houses and other business processing outsourcing (BPO) in India has led to an influx of over 7,85,000 new jobs. Outsourcing has changed the face of commercial real estate in India, but its greater impact has been the demographic shift characterised by rising disposable incomes and increasing consumerism. The real estate market in India predominantly continues to remain unorganised and fairly fragmented. It is mostly characterised by small players with a local presence.

Traditionally, developers were viewed with an element of scepticism, as people dealing with large amounts of unaccounted money, functioning in a non-transparent way and using unscrupulous means to obtain regulatory approvals. Lending to developers was perceived as a risky proposition as builders were known to borrow for one project and utilise the money for another, or overstretch their limits and not have sufficient funds to complete the projects. But things have clearly changed today: developers have realised the merits of corporatising themselves and enhancing x transparency in financial matters. While earlier even reputed builders had difficulty accessing formal channels of credit, today they have tie-ups with almost every bank and housing finance company, which are keen to lend to them at competitive rates. Lenders are also monitoring projects more closely. For instance, lending to developers is often through an escrow mechanism, which ensures that funds are utilised only for a designated project. Today specific projects of developers are also being rated so that the financiers as well as the end-users can take decisions easily while investing in a real estate project. The rating system also means greater amount of transparency on the part of developers.

In 2002, the government permitted 100 per cent foreign direct investment (FDI) in housing through integrated township development. The merits of FDI are well known x it provides the much-needed capital in the sector, brings professional players equipped with real estate expertise and facilitates the introduction of new technology. However, the FDI rules at present are rather stringent x prior approval of the Foreign Investment Promotion Board is required, which, admittedly can be rather tedious and there is a lock-in period for repatriation of the original capital invested for a period of three years.

What is rather self-defeating is the stipulation of a minimum land holding of 100 acres. Getting 100 acres of free land in an urban area is almost impossible. Consequently, barely a handful of projects have been approved. If the minimum area restriction is reduced at least by half and repatriation of profits after the construction is allowed, FDI in this sector will certainly pick up. Recently, the Securities and Exchange Board of India, India's capital market regulator, permitted venture capital funds to invest in real estate. This augurs well for the industry.

NOW to turn to housing finance in India. To understand the radical change that has happened in this industry, a brief history is required. The importance of the housing and real estate sector in India can be judged by the estimate that for every Indian rupee invested in construction of houses, 78 paise is added to the gross domestic product (GDP) of the country and the real estate sector is subservient to the development of over 250 other ancillary industries.

After agriculture, the real estate sector is the second largest employment generator in India. However, mortgage penetration continues to be abysmally low x in India the mortgage to GDP ratio is about 2 per cent. This compares poorly with a mortgage to GDP ratio of over 51 per cent in the U.S. However, even if one were to benchmark the ratio with more comparable counterparts, it ranges between 15 and 20 per cent for South East Asian countries. Thus the penetration level of mortgages is miniscule when compared with the shortage of housing units.

Traditionally, the government's support to housing had been centralised and directed through the State Housing Boards and development authorities. In 1970, the Central government set up the Housing and Urban Development Corporation to finance housing and urban infrastructure activities. In 1977, the Housing Development Finance Corporation (HDFC) was set up as the first company of its kind in the private sector in India. At that time, the business was looked upon with great scepticism x no one had so far experimented with retail housing finance in the country, there was no access to long-term domestic resources, and there was no legal system to support foreclosure. It is of course a different story that HDFC was successful. Even the World Bank has referred to HDFC as a model housing finance company for developing countries.

Although commercial banks were the largest mobilisers of savings in the country, traditionally banks were rather reluctant to lend for housing as they preferred financing the working capital needs of industry. Several banks had set up housing finance subsidiaries, which functioned as independent units with little support or interest from their parent banks. Towards the end of the 1990s, against the backdrop of lower interest rates, industrial slow-down, sluggish credit off-take and ample liquidity, commercial banks recognised that in order to maintain their profit margins, they needed to shift their focus from the wholesale segment and build their retail portfolios. The lower interest rate regime, rising disposable incomes, stable property prices and fiscal incentives made housing finance an attractive business.

Further, housing finance traditionally has been characterised by low non-performing assets. Given the vast demand for housing loans, almost all the major commercial banks plunged into the business of housing finance and thus began the roller-coaster ride. Some commercial banks devised extremely aggressive marketing campaigns to ramp up the size of their housing portfolios. This included intensive advertising campaigns, waivers of processing and administration fees, gift offers and other incentives, on-the-spot loan approvals without sufficient documentary evidence and loan-to-value ratios that exceeded 100 per cent. This was supplemented by cut-throat competition on the pricing front, with each new player trying to undercut the other.

This prompted critics to argue that the traditional players in the housing finance industry were fast losing ground. Admittedly, the smaller housing finance companies were struggling to match the aggressive pricing strategies of the new players and the survival of the smaller dedicated housing finance players was increasingly being debated.

Over the last year, however, banks have realised that while the demand for housing loans is tremendous, there is no substitute for prudent lending policies. Some banks have withdrawn from the housing loan market after being saddled with an unduly high amount of non-performing loans. Further, the Reserve Bank of India has sounded several warnings to banks, directing them to exercise caution in lending for housing finance.

While the furore in the housing finance industry appears to have abated, clearly the biggest winner is the customer. The housing finance industry today has been transformed into a 'buyer's market', with service standards having to keep pace with the ever-rising customer expectations. Today, customer retention is the greatest challenge. With the customer in a position of advantage, gone are the days of caveat emptor (buyer, beware). Today it has become 'lenders, beware'.

Lenders of housing finance have to be careful and recognise that there is no substitute for prudent credit policies, that the pricing of loan products have to be a function of costs and not competition and finally, that financial history is replete with disasters caused by asset-liability mismatches and thus short-term funds should not be indiscriminately used to fund long-term assets.

Real estate and housing finance are constantly transforming fields. Perhaps the situation is best summed up by Pol-Henry Cox, Managing Director, Jones Lang LaSalle, the well-known international property consultant, when he said: "If you are not in India today, you may as well not be in business!"

Renu Sud Karnad is Executive Director of HDFC Ltd.